Storing Bitcoin in Exchanges and Hot Wallets is Risky - What to Do Instead

From the massive security breach of the world’s largest bitcoin exchange Bitfinex, bitcoin users have learned a valuable lesson: to not store bitcoins on a custodial platform or an exchange.

Storing Bitcoin on a hot wallet, or a Bitcoin wallet that is connected to the internet, is fundamentally dangerous because of possible vulnerabilities in the systems of an exchange or a wallet platform that may enable hackers to compromise user funds.

Bitcoin exchanges store users’ bitcoins on hot wallets as they are required to send and receive bitcoins instantaneously upon the settlement of orders. For the same reason, reputable Bitcoin exchanges including Bitstamp and Kraken utilize hot wallets.

The flaws of multi signature technology

To reduce the vulnerability of hot wallets, Bitcoin exchanges typically integrate the multi signature technology which allows multiple parties to hold private keys of a wallet.

The advantage of using such technology is its ability to grant exchanges the capability to prevent suspicious or risky transactions from being processed after thorough verification and authentication.

Bitfinex and BitGo implemented the multi signature technology in the Bitfinex exchange platform. Private keys were distributed amongst three parties including Bitfinex, BitGo and the user, allowing BitGo and Bitfinex to authenticate each transaction.

In contempt of the integration of the multi signature technology and partnership with BitGo, hackers still managed to steal millions of dollars worth of Bitcoin with a sophisticated piece of malware which Bitfinex is yet to identify.

Don’t store large sums of Bitcoin in one entity

Bitfinex has announced that it will take full responsibility of the theft, explaining that BitGo’s Bitcoin security platform wasn’t breached. BitGo confirmed this statement and Kraken, another major exchange which currently collaborates with BitGo, announced on social media that the exchange plans to use BitGo’s services.

While Bitstamp and other exchanges have criticized the infrastructure and security measures of the Bitfinex exchange, HaoBTC told its users that they shouldn’t store large sums of Bitcoin in one entity, including themselves.

Blockchain.info, the world’s most popular Bitcoin wallet service provider, also stated on social media that users must use non-custodial Bitcoin wallets for storing Bitcoin.

Regardless of the extensive security measures of an exchange, any wallet that is connected to the Internet can be subjected to security breaches and hacking attempts.

Thus, users must refrain from storing large sums of Bitcoin in exchanges and in hot wallets.